Old Second Bancorp, Inc.

Good morning, everyone, and thank you for joining us today for Old Second Bancorp Incorporated's third quarter 2024 earnings call. On the call today are Jim Ecker, the company's chairman, president, and CEO, Brad Adams, the company's COO and CFO, and Gary Collins, the vice chairman of our board. I will start with a reminder that Old Second's comments today will contain forward-looking statements about the company's business, strategies, and prospects, which are based on management's existing expectations in the current economic environment. These statements are not a guarantee of future performance and results may differ materially from those projected. Management would ask you to refer to the company's SEC filings for a full discussion of the company's risk factors. The company does not undertake any duty to update such forward-looking statements. On today's call, we will also be discussing certain non-GAAP financial measures. These non-GAAP measures are described and reconciled to their GAAP counterparts in our earnings release, which is available on our website at oldsecond.com, on the homepage, and under the Investor Relations tab. Now, I will turn it over to Jim Ecker.

Good morning, everyone, and thank you for joining us. I have several prepared opening remarks. and we'll give you my overview of the quarter and then turn it over to Brad for additional details. I will then conclude with certain summary comments and thoughts about the future before we open it up to Q&A. Net income was $23 million or $0.50 per diluted share in the third quarter of 2024, and return on assets was 1.63%. Third quarter 2024 return on average tangible common equity was 17.14%, and the tax equivalent efficiency ratio was 53.38%. Third quarter 2024 earnings were negatively impacted by $2 million of provision for credit losses in the absence of significant loan growth, which reduced after-tax earnings by $0.03 per diluted share. However, despite this, profitability at Old Second remains exceptionally strong, and balance sheet strengthening continues with our tangible equity ratio increasing by 75 basis points linked quarter to 10.14%. Common equity tier one increased to 12.86% in the third quarter, and we feel very good both about profitability in our balance sheet positioning at this point. We are pleased to announce a 20% increase in the common dividend this quarter, reflective of continuing strong profitability and a well-capitalized balance sheet. we'd like to position ourselves to regularly deliver growth in the common dividend as we continue to build Old Second into one of the best banks in Chicago. Our financials continue to reflect a strong net interest margin, even as market interest rates begin to decline. Pre-provision net revenues remain stable and exceptionally strong. For the third quarter of 2024, compared to the prior year-like period, income on average earning assets increased $1.8 million, or 2.5%, while interest expense on average interest-bearing liabilities increased 4.3 million or 38.4%. The increase in interest expense is rate-driven and primarily due to remixing and market pricing on certain commercial deposits. The third quarter of 2024 reflected an increase in total loans of 14.5 million from the prior linked quarter end, primarily due to growth in commercial, lease, and construction portfolios. net of payoffs on a few large credits during the quarter. Comparatively, loan growth in the third quarter of last year was $14 million, which is in line with the 2024 late quarter's total loan growth. The historical trend in our bank is loan growth in the second and third quarters of the year due to seasonal construction and business activities. Currently, activity within loan committee is improving but remains relatively modest to prior periods. primarily due to many customers waiting to see how market volatility, including election results and any further interest rate reductions, play out in the next three to six months. The tax equivalent net interest margin increased by one basis point in this quarter, driven by continuing higher rates on variable securities and loans, partially offset by higher funding costs. Loan yields reflected a 16 basis point increase during the third quarter compared to the link quarter, and 28 basis point increase year over year. Funding costs increased due to increases in both rates and growth in time deposits. The tax equivalent net interest margin was 4.64% for the third quarter of 2024 compared to 4.63% for the second quarter and 4.66% in the third quarter of last year. The net interest margin has remained relatively stable in the year-over-year period due to the impact of rising rates on both the variable portions of the loan and security portfolios, as well as the deposit base and our short-term borrowing costs. The loan-to-deposit ratio is at 89% as of September 30th, compared to 88% last quarter and 87% as of September 30th, 2023. As we have said in the past, our focus continues to be on balance sheet optimization. I'll let Brad talk more about that in a minute. The third quarter of 2024 saw improving asset quality metrics and moderate actions taken on substandard credits. Continuing remediation trends noted primarily since late last year. Our belief remains that the fourth quarter of 2023 represented an inflection point in our credit trends. Old segment began substantially downgrading large amounts of commercial real estate loans, including office and healthcare at the end of 2021 and accelerating through 2022. Substandard and criticized loans went from approximately 60 million or a little more than 1% of loans at third quarter of 2021 to a peak of nearly 300 million or over 7% of loans in the first quarter of 2023. As of the end of the third quarter of 2024, substandard and criticized loans are down 187.6 million, which is essentially flat to last quarter and approximately 15.7 million less than year end 2023 and more than 40% below peak levels. The expectation remains for further improvement through the rest of the year. Encouragingly, our special mention loans decreased 45.6 million or more than 37% from a year ago. We continue to expect realization of a relatively less costly resolution on a number of non-performers in the near future and remain hopeful we can recover some of those losses realized in the second half of 2023. In the third quarter of 2024, we recorded net recoveries with the allowance for credit losses on loans of $155,000 compared to net charge-offs of $5.8 million in the second quarter of this year and net charge-offs of $6.6 million in the third quarter of 2023. Prior quarter elevated net charge-off levels and continued asset remediation efforts have resulted in a more stable credit outlook on current problem loans. And the good news is that classified loans continue to decline, falling by almost $10 million in the third quarter, with the remainder of the portfolio remaining well-behaved. Continued stress testing has not raised any new red flags for us, and the bulk of our loan portfolios transition into the higher rate environment and will be impacted with downward rate movements going forward. The allowance for credit losses on loans increased to $44.4 million as of September 30, 2024, or 1.11% of total loans from $42.3 million at the end of the second quarter, which was at 1.06% of loans. Unemployment and GDP forecast used in future loss rate assumptions remain fairly static from last year, with a 25 basis point uptick in the unemployment assumptions on the upper end of the range based on recent Fed projections. The change in provision level quarter over link quarter reflects the reduction in our allowance allocations on substandard loans, which largely relates to the 29% reduction in criticized assets since September 30th of 2023. I think investors should know that with our continuing level of strong profitability, we will be aggressive in addressing weak credits, and we remain confident in the strength of our portfolios. Non-interest income continued to perform well with growth relatively flat in the third quarter of 2024 compared to the linked quarter in wealth management fees, service charges on deposits, card-related income, and mortgage income, excluding the impact of mortgage servicing rights mark-to-market. A death benefit of $893,000 was realized on one bully contract in the second quarter of 2024 with final true-up of these proceeds in the third quarter of 2024. No like benefit was recorded in 2023. Other income increased in the third quarter of 2024 compared to the prior link quarter and prior year like quarter due to recoveries on a vendor contract and refunds of prior servicing advances on a solo credit card portfolio. Expense discipline continues to be strong with total non-interest expense for the third quarter of 2024 at $1.4 million more than the prior late quarter, primarily due to an increase in incentive accruals and the first merchant's acquisition costs incurred of $471,000 in the third quarter. OREO expenses also increased in the third quarter of 2024 compared to the prior quarter as the second quarter included a net gain on the sale of OREO of $259,000. Our efficiency ratio continues to be excellent as the tax equivalent efficiency ratio adjusted to exclude acquisition costs and BOLI death benefits was 52.31% for the third quarter compared to 52.68% for the prior late quarter. As we look forward, we are focused on doing more of the same, which is managing liquidity, building capital, and also building commercial loan origination capability for the long term. The goal is obviously to continue to create a more stable long-term balance sheet mix featuring more loans and less securities in order to maintain the returns on equity commensurate with our recent performance. With that, I'll turn it over to Brad for additional color.

Thanks, Jim. I don't know if there's a ton more for me to talk about. I think Jim covered a lot of things. Net interest income increased by a little less than $1 million, or 1.5%, to $60.6 million for the quarter ended September 30th, relative to $59.7 million last quarter. Securities yields increased 17 basis points, and loan yields increased by 16 basis points. Total yield on interest-earning assets up by a similar 16 basis points. to 583 basis points in aggregate. This is partially offset by a 15 basis point increase in the cost of interest-bearing deposits and 19 basis point increase to interest-bearing liabilities in aggregate. The end result of that was a one basis point increase in the NIM, basically making my guidance from last quarter wrong yet again, but not by much. Obviously, we have rate cuts now, 50 basis points and more expected in the forward curve, which tends to show up in market indices before the cuts actually happen and does impact our margin. I don't have anything different to say in terms of the guidance there. I still think it's around seven basis points per 25 basis point cut impact to the margin. That will be mitigated somewhat in the near term by the announced acquisition of five branches and a couple hundred million in deposits that are coming with that that we expect to close in early December. Deposit flows this quarter were pretty much stable, nothing like the volatility we saw last year and earlier this year. Average deposits decreased by $91 million or 2% quarter-over-link quarter, and period-end total deposits somewhat better at $56.3 million or 1.2%. Deposit pricing in our markets has come down a bit, but it remains exceptionally aggressive relative to the Treasury curve and is still largely pricing off overnight borrowing levels. Public funds has provided a bit of a headwind, as fixed income markets offer an attractive alternative to some customers. My overall position remains, and excuse me while I talk our book here for a minute, but my overall position remains that that markets continue to believe that inflationary trends are far easier to kill than they actually are. The level of rate cuts reflected in the forward curve is not a realistic expectation without significant declines in real demand and consumption, otherwise known as a recession. My current expectation does not include a near-term recession with the amount of fiscal and monetary largesse that is currently on the table. As a result, I see very little value in duration at this point. and cash flows are being reinvested in variable rate opportunities. With credit spreads unbelievably tight, there is simply no value out the curve at this point relative to the risk. So poor marginal spreads persist, and Old Second is continuing to focus on compounding book value and maximizing returns. For us, that means being careful with expenses and pricing risk appropriately. As a result of the recent rate cuts and their impact on these market indices that I referenced, margin trends for the remainder of the year are expected to trend down modestly. The magnitude will be mitigated by the expected closure of the branch acquisition, as I mentioned. Success in funding loan growth with these newly acquired deposits offers the opportunity for upside to these expectations. The loan-to-deposit ratio is still very low at below 90%, and our ability to source liquidity from the securities portfolio remains excellent. AOCI on the portfolio came down by some 30% this quarter, which resulted in some of the capital build that you saw. I think that illustrates what we had been talking about in terms of where that portfolio was positioned on the curve and seeing improvement that may be somewhat better than others are seeing at this point, given the short overall duration of the portfolio. I think capital build will slow from here. And I do believe that the overall M&A environment remains very favorable to a bank like Old Second. If that does not come to fruition, we will return capital. A buyback is still in place and is on the table. Non-interest expense increased $1.4 million from the previous quarter, primarily due to acquisition-related costs, an increase in officer incentive accruals, and an increase in net Oreo-related expenses due to ongoing credit remediation. The small gain recorded in OREO last quarter. Given the bottom line performance, employee investment costs have been running high, but we will maintain the ability to dial that back as conditions warrant. That's all I really have with that. I'd turn the call back over to Jim. All right. Thanks, Brad.